The year 2009 saw the UK move into a full-blown recession. This was the result of sharp falls in both consumer expenditure and investment caused by the crisis in the financial markets. Both the Bank of England and the Treasury responded with expansionary policies in an attempt to arrest the decline in real output. The Bank of England cut interest rates virtually to zero and resorted to the more direct monetary mechanism of quantitative easing.
At the same time, the Treasury allowed the budget deficit to increase to levels well beyond those previously considered prudent. These measures had some success in averting the worst of the recession. However, it is not clear how long the policy authorities can continue with policies like these. In the longer term, the sharp increases in the monetary base associated with quantitative easing may add to inflationary pressure. Similarly, there is a limit to the financing of budget deficits before the cost of such finance begins to rise and the financial markets start to downgrade the credit worthiness of government.
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